Apprenticed Investor: Nothing Doing

Let's be blunt: There is something exhilarating, even thrilling, about trading. The adventure of putting a position on, the buzz of watching it rally -- it can be such a delight that it almost feels illicit.

Clearly there is a rush to trading, especially when the market is really hot. But if you are getting that excited by trading, then the odds are you have become far too emotionally involved in the trade.

This is a huge mistake.

Investing is serious business, with real dollars at stake. There are far cheaper, less dangerous ways to buy a thrill -- hang gliding comes to mind -- than trading and investing.

There's nothing wrong with having, say, 5% of your portfolio in a "mad money" account for more speculative trades or just to have "some skin in the game." But if you are trading to get your jollies, then you are not spending your money well.

So today, I'd like to talk about nothing; specifically, about doing nothing.

There are times when doing nothing is your best course of action. But knowing when to sit one out is a problem many investors have.

Become a Card Counter

A wiser man than me once observed, "Give me an edge, or I won't play."

In blackjack, professional gamblers keep track of the cards that have already been dealt. This gives them insight into the odds the remaining cards in the deck hold. That slight edge is enough for card counters to win regularly at the game -- and to eventually get banned from casinos.

Investors should play only when they can stack the deck in their favor. For example, I had terrific insight into Apple ( AAPL) very early, having gotten one of the demonstrator iPods in late 2002. It was so apparent to me this was going to be a monster hit that I had a huge leg up over those who hadn't been playing with the gadget. As I watched white ear buds sprout on my commuter train more and more, I knew it was a matter of time before the stock would react. That's a tradeable edge, which I took advantage of by getting long Apple before the rest of the world realized the impact of the iPod.

Same for Google ( GOOG): I was a beta tester of the search engine early on, and it gave me insight into how vastly superior its search technology was long before the time of the IPO. The caveat is that once the entire world discovered Google, my edge disappeared.

Sometimes, we have an edge and don't even realize it. I am a huge Ray Charles fan, and I knew of Starbucks' ( SBUX) release of what was to be his final album, Genius Loves Company.

I should have realized that Starbucks was morphing from a coffee retailer into a "lifestyle purveyor." The company's music sales drew customers into the store. I should have suspected that the Aug. 31, 2004, release of the CD would positively impact the whole chain. That's a missed opportunity because I didn't even think about what turned out to be an edge.

As an investor, I want the deck stacked in my favor as often as possible. When I have little or no advantage, I'd simply rather not participate. That may mean avoiding specific situations or closing out a losing position. It also may mean knowing when to sit out a directionless, choppy market altogether.

The Lesson of Folding

At the RealMoney.com panel discussion at the online expo in New York in January 2002, I actually overheard someone in the crowd say: "Stocks suck lately."

That's the equivalent of the poker player who says: "Man, that deck was cold for me tonight!" This player thinks it was the cards' fault. Guys like that helped pay for my undergraduate education.

When I'm playing poker, if I don't like the cards I'm dealt, I fold. It's that simple. Lose the ante, wait for the next shuffle. Unlike the professional baseball player, I don't have to face a wicked knuckleball pitcher. Likewise, you don't have to force a trade or an investment.

Unlike the poker player, investors don't have to even lose the ante. If you don't like the look of the table, you can say "deal me out."

Think about how people have been describing the investing environment in the past year: "What a tough, lousy market." If that's the case, then why play if you do not have to?

Focus on your decision-making process. Ask yourself these questions: How active should I be now? What sectors are working this quarter? What size lots should I buy now?

All too many investors are on autopilot; they always buy 1,000-share lots, they trade the same stocks, they make about the same number of trades per week. Why even trade if you don't like the market? That's a decision that too many people make without actually considering their options carefully. In short, they do the same things regardless of the conditions.

If you are not a card player, consider skiing: It requires constant adaptation to rapidly changing terrain conditions. If the mountain gets too icy, I like to sit in the lodge with the ski bunnies, drinking hot toddies. We have a phrase for those skiers who fail to recognize changing conditions and adapt to them: badly injured. So, too, can investors get badly injured by forcing the situation when they don't need to.

Participating in a given market or stock should be a conscious, well-thought-out choice. All too often, it appears to be one made on autopilot, and that is never good for anyone's returns.

I can trade from the long or short side, hedge with options, choose sectors, lot sizes, activity. In short, I can control the trade.

Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries, and is a member of the board of directors of Burst.com, a streaming media software company. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback;
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